Wall Street. A term that designates not only a physical place, but a symbol, a way of thinking. It’s the capital of investing (embodied in the stock market), the capital of high finance (embodied in the banking system), the capital of… capital. It’s the hub of the economy, domestically and internationally.

And it’s the single biggest stumbling block in the Obama administration’s attempt to get the economy back on track.

Wall Street’s era of global dominance may well be over for good. At the very least, its era of freewheeling, unregulated, devil-may-care profitmaking is certainly dead and gone. Yet the Street (to the extent it can be said to have a collective will) is still acting as if it’s calling the shots.

The buzz lately is all about nationalizing failing banks. Economists from Paul Krugman to Alan Greenspan, public officials from Chris Dodd to Lindsey Graham, are all saying that it’s the only sensible approach to resolving the problems on their murky balance sheets and getting them to behave (and lend) in a way consistent with public policy goals. Yet when the mere rumor of such plans on Pennsylvania Avenue was bruited last week, the Dow plunged dramatically, prompting Obama’s spokespeople to rush forward and insist that nationalizing banks was not on the agenda.

It should be, though.

The TARP passed last fall has been a disappointment to almost everyone, as Hank Paulson went about handing out money with no concern for accountability, and the financial sector went on about business as usual. The proposals thus far from Timothy Geithner, now occupying Paulson’s old office at Treasury, are only marginally more credible. For instance, he wants to swap some of the government’s equity stake in big institutions like Citicorp from preferred stock to common stock—which would give the taxpayers a voting voice on management decisions. Yet he’s hastened to assure everyone that this doesn’t mean Uncle Sam will wind up taking a majority stake, or calling the shots.

It should be, though.

I can understand the reservations from both sides. To some on the right, the very word “nationalization” evokes Communism, the spectre of banks being taken over at gunpoint by tinpot third-world kleptocracies. To some on the left, it raises worries of a shell game, in which the taxpayers will “take over” all the bad debts, then hand clean shiny profitable institutions back to rich shareholders at no cost to them.

Both of these versions are, of course, worth avoiding. But there’s a more rational approach that can and should work. The way to do it was summarized very effectively in the pages of The Nation:

The more promising path is for government to take charge of the system. This approach—call it “supervised workouts” if “nationalization” sounds too scary—would be more efficient than handing over more billions to failed bank executives and asking them to do the right thing. The government should liquidate the troubled big banks (along with the arcane financial instruments that led to their downfall), sell off their parts to healthier enterprises and let the shareholders eat the dust. Scarce public capital can meanwhile be used to fashion a new banking system, built around the thousands of smaller banks and financial firms that respect their obligations to the broader economy by investing in production and jobs. It will take some years to do this, and government will temporarily have to fill in the blank spots in the credit system that are not functioning, but it’s probably the only way out.

It worked for Sweden in the ’90s, and with appropriate safeguards to avoid the extremist scenarios sketched out above, it would work here. It even averts the worst of the “moral hazard” arguments so prevalent these days—the greatest costs wind up being borne by the players who chose to take those risks in the first place. (Remember, most traditional banks are decently capitalized, and on average have actually increased lending over the past year. The thing is, “traditional banks” only account for about 30% of credit in today’s economy, far less than they used to—and it’s with the rest, with the investment banks, the private capital and securities markets… with Wall Street… where the real problems lie. That imbalance needs to be corrected.)

The thing is, we’re wasting time rather than acting on this, because right now Wall Street is standing in the way—even if only by holding a gun to its own head (in the form of the Dow) and threatening to shoot if Washington doesn’t back off.

Of course, the only thing that would actually make Wall Street happy would be to continue to shovel vast sums of money its way with no strings attached. The Obama administration shouldn’t fall for this kind of extortion, and frankly can’t afford to. Without serious corrective action in the larger economy, the stock market has nowhere to go but down anyway. Really, Wall Street should appreciate the concept—it’s always embraced it in the past!—that he who supplies the capital calls the shots. And right now, that’s you, me, and all our fellow taxpayers.

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7 Responses to “The weak link is Wall Street”
  1. Here’s the thing — if your small local bank has behaved in a relatively responsible way, then you’re right that it’s unlikely to be in any danger. It’s mostly the larger corporate behemoths with functions that go beyond ordinary banking (investment banking, etc.) that overleveraged themselves.

    Either way, though, if you’re a stockholder in a bank that’s insolvent… well, think about what “insolvent” means. When liabilities exceed assets, owner equity (i.e., shares) is the first thing that goes away, with or without government involvement. If the only ways to keep the balance sheet balanced are either constant inflows of new capital from the taxpayers (which costs you as well, and also dilutes existing shares), or flimsy accounting tricks that value assets higher than they’re actually worth… then it’s just as well to restructure the institution. Take it over, break it up, sell off the pieces, and move on.

    History shows that it works. For some reason, though, a lot of current stockholders seem to prefer a long, slow wasting disease rather than a quick amputation that could save the patient.

    As to the last paragraph… if accepting TARP funds that aren’t needed creates any sort of “competitive advantage,” then someone somewhere is pulling a fast one. I hesitate to speculate about the details, though.

  2. Glenn Simpson says:

    I find myself in an odd position. One, I own stock in a small local bank, and I would certainly not appreciate my stock being rendered worthless in the name of fixing the banking system. If the government wants to require me to pay them my stock at a fair price (rather like selling them some of my land to build a road), I’m good with that.

    On the other hand, with it being a small banking system, one could say that I’m in no position to worry, since it’s just the big banks that would be affected.

    But on yet another hand, I happen to know that my bank is planning to accept some TARP funds (and the strings attached) even though they don’t need them, because all of the OTHER banks in the area are doing so, and are going to have some sort of competitive advantage over my bank if my bank doesn’t. So that potentially puts my bank (and stock) potentially back into a danger zone.

  3. Thanks, Phil, for the interesting commentary from Posen. It certainly seems to reflect the emerging consensus among those who know what they’re talking about (or, like me, who are at least struggling to stay apace of developments).

    BTW, you know it’s actually pretty easy to embed a link to an item like that…

    Did anyone happen to hear the hour-long report on this week’s This American Life about the banking crisis? I don’t usually listen to the show, but when they do one of these in-depth economics pieces, it’s always worth the attention. Did a great job of laying out the whole situation (especially the status of investment bank balance sheets) in terms even a layman can understand.

    Anyhow, a couple of somewhat reassuring thoughts: one, as Michael notes, the opposition really isn’t from “the right,” at least not in its usual coordinated way. It’s only from a handful of Wall Street financial players who still profess to be shocked, shocked! to hear that there’s gambling going on around here. Two, if the administration actually is planning to nationalize some banks (Citicorp, BofA, I’m talking about you!)… well, honestly, they’re not going to tell anyone about it in advance. That would just cause a rush for the exits. They’ll keep their own counsel until it’s a fait accompli.

  4. phil from new york says:

    I agree with Chris and Michael. Unfortunately, the administration appears to be emulating the Japanese approach of the ’90s to deal with the banks. From Paul Krugman’s blog at The New York Times web site, here is testimony prepared by Adam Posen of the Peterson Institute for International Economics for the Joint Economic Committee:

    “The guarantees that the US government has already extended to the banks in the last year, and the insufficient (though large) capital injections without government control or adequate conditionality also already given under TARP, closely mimic those given by the Japanese government in the mid-1990s to keep their major banks open without having to recognize specific failures and losses. The result then, and the emerging result now, is that the banks’ top management simply burns through that cash, socializing the losses for the taxpayer, grabbing any rare gains for management payouts or shareholder dividends, and ending up still undercapitalized. Pretending that distressed assets are worth more than they actually are today for regulatory purposes persuades no one besides the regulators, and just gives the banks more taxpayer money to spend down, and more time to impose a credit crunch.

    “These kind of half-measures to keep banks open rather than disciplined are precisely what the Japanese Ministry of Finance engaged in from their bubble’s burst in 1992 through to 1998 . . . .”

    I want to believe Obama is thinking several steps ahead of us and knows he’s going to have to “nationalize” several big banks – calling it anything but that name – and he’s just getting us ready for it. But I don’t know. Many in Wall Street and elsewhere want to pretend that the banks aren’t insolvent. They are. And we’re never going to have a recovery until everyone realizes this and deals with it (including the pearl-clutching establishment media who are in full socialism panic mode right now.)

    Right now the public appears to support whatever Obama wants to do to help the economy. Support for his economic plan surged to almost Bush-like 9/11 numbers after the president’s speech before Congress the other night. The polls also show the voters think the Republican should be doing more to cooperate with him, not the other way around. Obama’s never going to have more support for taking aggressive action to help the economy than now.

    Yet, as I keep reminding myself, Obama is an establishment Democrat. He hasn’t surrounded himself with big-time liberal policy makers. Many of us may want him to be a 21st century FDR, and maybe he will be, but he may have to be forced into it. The thing is, his presidency, as well as the fate of the country, is on the line here. And even a few Republicans appear to realize that wanting Obama to fail is like the Cleavon Little character in Blazing Saddles putting the gun to his head and threatening to pull the trigger. (On second thought, that may not be an apt analogy, but I think you get my point.)

  5. Makes sense for the time being, but I don’t live there. Which makes me just a meddler right now.

  6. No, “capitol” is a specific building; “capital” is a more generalized area.

    Other than that, yeah, we basically agree. The whole point of the post was that the administration should be more aggressive about this.

  7. michael says:

    Okay, first things first: Wall Street is the *capitol* of capital. But second, the problem is not that the Right fears nationalization—they are calling for it—but that Obama’s economic team fears it. What possessed him to involve someone like Summers is beyond me. The guy is astonishingly arrogant, politically inept and far less qualified than he and Obama think. But the whole crew is hell-bent to stick with the private enterprise dogma, as even the newly revised banking plan clearly shows. Taking a position in Citigroup is truly the most radical step they are prepared to contemplate. Hell, at $1.50 a share, they could buy the whole thing outright for less than it will cost to prop it up. Why doesn’t owning a bank qualify as letting the market work? Don’t we own them already in our mutual funds, pension plans, insurance policies, retirement accounts, and the bailout?

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